Eddie Lampert vulnerable on dual fronts after Lands' End spinoff

(Bloomberg) — Even after spinning off Lands' End, Sears Holdings Corp.'s Eddie Lampert remains vulnerable on dual fronts: a struggling retail business in need of a new strategy and a hedge fund whose investors have begun pulling their money.

The Lands' End spinoff, announced Dec. 6, gives Sears investors a piece of a profitable clothing brand no longer hindered by an association with the loss-making Sears. Yet the move may not raise capital that Lampert, the company's largest shareholder, can plow into the business, which is burning cash amid dwindling traffic to rundown stores.

Separately, Lampert issued Sears stock last week to investors redeeming shares in his hedge fund, ESL Partners LP. The moves reduced his stake in the department-store chain to 48 percent from 55 percent. Additional redemptions by ESL Partners holders could reduce his Sears stake further, loosening his grip on a company he's controlled for nine years.

“His investors are running out of patience,” said Erik Gordon, a professor at the University of Michigan's Ross School of Business in Ann Arbor. “He's running out of time to keep pulling rabbits out of the hat. He's going to have to start producing sales in the stores.”

Sears declined to make Lampert available for comment.

A mercurial and remote leader who has presided over a revolving cast of executives, Lampert has confounded retail analysts by introducing and abandoning one strategy after another. His latest idea is to turn Sears into a membership chain centered around its rewards-card program. How this is supposed to return Sears to growth remains unclear.

DIVIDING COMPANY

Adding to his challenges, Lampert has pitted executives against one another by dividing the company into separate operating units, according to dozens of former executives.

The shares fell 1.1 percent to $47.54 at 9:41 a.m. in New York. They had gained 16 percent through Dec. 6, compared with a 41 percent gain for the 31-member Standard & Poor's 500 Retailing Index.

Sears Holdings, which includes the Kmart chain, has posted six years of declining revenue in large part because Lampert has underinvested in the stores. In 2012, the company spent about $1.51 a square foot on its Sears stores and $1.04 on its Kmart stores, compared with $5.56 at Home Depot Inc., and $6.25 at Macy's Inc., according to Matt McGinley, a managing director at International Strategy & Investment Group in New York.

There is less and less money to update them -- even if Lampert were inclined to. Sears's operations have consumed cash for six of the past seven quarters. The retailer said last month that it had $607 million in cash as of Nov. 2 and that it expects to generate $2 billion of liquidity in the current fiscal year, up from an earlier forecast of $500 million.

SEARS TRANSFORMATION

“It's not fair to say we haven't invested in the future and transformation of the company,” Howard Riefs, a Sears spokesman said in an e-mail. “Store investment may be necessary but it's not sufficient in helping to transform a traditional retailer to a retailer that's more competitive.”

Sears is shifting into a business that serves customers “in the manner most convenient for them: whether in store, in home or through digital devices,” he said.

To shore up the balance sheet, Lampert has been selling off assets. Last year, he split off Sears's smaller-format Hometown and Outlet stores to raise about $446.5 million. He also spun off a portion of Sears's stake in Sears Canada as well as an investment in the Orchard Supply hardware stores.

Selling Lands' End may not have been an option for Lampert because he wouldn't get anywhere near the $1.9 billion Sears paid for the brand in 2002, according to Paul Swinand, an analyst at Morningstar Inc. in Chicago. Lands' End would probably fetch no more than $1 billion, he said.

SPINOFF PAYOUT

The retailer still could structure the spinoff to include a payout to the parent company or to investors, said Mary Ross Gilbert, an analyst at Imperial Capital LLC in Los Angeles. Sears could issue $100 million to $300 million in debt to fund such a payout, she said.

“While this is favorable to the shareholders, it's detrimental to creditors,” Gilbert said. “As they sell off or spin off these profitable businesses, these cash-generating businesses, you're left with higher losses at Sears.”

Next on the block: the retailer's automotive unit, a chain of more than 700 service centers offering repairs and routine maintenance such as oil changes. Estimates of how much the business is worth range from $600 million to $1 billion. However, because there are no competitors with national scale, finding a strategic buyer may be difficult, McGinley said.

RAISING CASH

Lampert has been raising cash by selling stores and leases, too. He sold 11 locations to General Growth Properties Inc. for about $270 million in cash proceeds last year. In October, the company said Sears Canada is selling five store leases to Cadillac Fairview Corp. for C$400 million ($376 million). Sears said it is continuing to evaluate its U.S. stores, including leased locations that are set to expire.

Vadim Perelman, whose Baker Street Capital Management is Sears's ninth-biggest shareholder, remains bullish on Lampert's vision and in September issued a report called “The Case for Sears Holdings,” which argued that the company's real estate is worth more than $7 billion.

“We think the business will look quite different in three to five years,” Perelman said in an interview. “We think they're working pretty hard to figure out a way to become profitable, or less unprofitable.”

While Lampert said last week he's still focused on creating long-term value at Sears, he has lost the faith of a group of clients that invested about $3.4 billion in his main fund, ESL Partners, as early as 2007, when the stock was trading at much higher prices.

LAMPERT REDEMPTIONS

All of the investors were required to commit their money for at least five years, Lampert's standard lockup period, a person familiar with the situation said last week. By the beginning of this year, ESL had received notice from these investors that they wanted to redeem all of their money, the person said. ESL had the right to meet the redemptions over a one-year period rather than pay out at once.

Lampert's firm began returning the money last year and continued to do so this year, using both cash and securities such as stock in AutoNation Inc., AutoZone Inc., and Sears, according to the person, who requested anonymity because the information is confidential. In June, ESL Partners reported in a regulatory filing that it distributed $393 million of AutoNation shares to clients who had elected to redeem all or a portion of their investment in the fund.

FIVE-YEAR LOCKUP

Still, even if other Lampert investors have lost confidence in Sears, they may not flee the fund because they are bound by the five-year lockup. Besides, Lampert's U.S.-traded stock holdings, which include shares in AutoZone, AutoNation and Gap Inc., have gained 25 percent this year.

“A lot of things are coming together at once,” McGinley said. “His fund is highly concentrated in Sears. As the CEO of the company, I'm sure his primary focus is on making sure that this thing is a viable concern so that his limited partners in his position don't get wiped out.”